First Non-Major Gap-Up Monday in a while

I’ve responded here using voice chat so some of this might come out jumbled.

So there’s a few things we need to do. First we need to outline and analyze all of the conditions under which the QQQ has ever only corrected 8%

I recently discovered, prompted by a question from Derek, that 8% corrections are exceedingly rare anytime we have a rally that surpasses 20%

So while they do happen, the times that they have happened, have always come after the end of a bear market or after a small sub 20% rally commence it with the size of the 8% correction.

So here’s the matrix.

The first question you ask is: has the rally exceeded 20%? If the answer is yes, then you ask:

Is this rally an immediate bear market recovery rally off of some major bear market low?

If the answer is NO to the second question, then we’ve found that it is extremely rare to see an 8% correction.

I think we only have like two cases total where the rally was more than 20% and we still had an 8% correction. It is rare during mid bull market cycles is the key.

The two true exceptions we have are first we had a small correction after the QE2 rally. After Ben Bernanke’s Jackson Hole speech causing a bottom in the summer 2010 correction, the QQQ went onto rally from August to November in an explosive 30% run that ended in a very minor 5-7% correction.

It was a tiny hiccup like around Thanksgiving. That was one exception.

The other exception happened in April 2024. In April 2024, the QQQ had come off of a big 30% rally that began in November 2023 and ended in April 2024.

Now, interestingly, what we’ve found is that in both cases, they occurred after the marked had sustained a very long down period.

Both the QE2 rally and the November 2023 rally happened under exceptionally similar circumstances. Both rallies sort of be began after the market had spent 70-80 days in correction mode.

Maybe that has something to do with it. Hard to tell.

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But the skinny of it all is this. 8% corrections are extremely rare.

Still, we do need to protect ourselves in the sense that we don’t wanna lose the opportunity of capitalizing on the next rally

Then again, every time we’ve ever only had a small 8% correction the next rally was very short-lived and led to a massive sell off in both case cases

Like sure we had a continuation of the QE2 rally that went into 2011 but then we had a humongous sell off in 2011

In April 2024, while the QQQ only sustained a 8% correction, the next rally only lasted 55 sessions, ended in mid-July and produced only 20% returns. The correction that followed that was 16%. It was a major correction. That correction was a 100% retracement of the previous rally.

And then we had another 8% correction in September 2024 for good measure.

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The point here is this: even if we only end up with an 8% correction the likely impact of that is the QQQ probably doesn’t go very far and the next rally ends in a gigantic correction anyway. At least that is what we’ve seen historically.

So for example, let’s suppose the QQQ only pulls back to 580 in what ends up being an 8% correction. Even if that happens, the next thing that’s going to occur from there is maybe a rally to around 700 very swiftly which probably leads to a correction down to 550 a share or worse.

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Now with all of that in mind, normally what we would do is say “let’s buy half of our long position at 8%.” if we launched a brand new portfolio we would go 50% long at the 8% mark.

So in Arryn, for example, since we have around $240,000 in cash, normally we would be buying a $120,000 total position — hedge and all — and we sit on 120 K cash.

That’s the general idea. It probably wouldn’t be like that to be honest with you. But that’s the general notion we should be buying about $120,000 long position + hedge.

In reality if we went that route, we would just buy the $120,000 long position and continue holding the large hedge that we have

Then, if the QQQ goes lower, we would reduce that hedge and use the capital to add to that long call.

That’s a totally valid way to do it and I’ll have to show the math on this but that’s one valid way to approach things

The other way to approach things is to say hey look instead of throwing out $120,000 into a long leap position, we buy a smaller position spread that would pay off if the QQQ decided to only have an 8% correction.

What we would need to do is figure out the exact call-spread that would allow us to produce the same exact return in some long leap position

So the math on this would be to identify what we would buy if we bought leaps. In this case, it would be something like the June 2027 $580 leaps.

We would then determine what the return rate would be if the QQQ climbed 20% What would we return on a 20% move to the upside from 580 per share by owning the June 2027 580 leaps at a $120,000 investment.

We would then need to determine how to produce that same return but with an intermediate term call-spread that requires us to put up less capital.

The trick here though is to ensure that we have so much time that even if the QQQ decided to go full-blown hard-core correction, the rebound back to the highs would allow us to profit on that position. The problem is the further out we go, the more costly the asset.

My thinking is go way up, but have a lot of time. Because the reality is after this correction ends, we are likely going to rally big and probably toward 700 to share.

So for example, a 20% run from 580 share puts us at 700. So what we would want to buy probably is a longer term s$690-$700 call spread. We would probably be looking at something like that. Because again these rallies they go for a minimum of like 20%. When the QQQ begins a rally that’s what you could expect.

And remember since we’re putting up a much smaller position, we take less of a hit if the QQQ sustained a large correction. But we produced the same return if the QQQ decides to takeoff with us on the sidelines.

That’s the key goal here produce the same return on the way up. Take a much smaller loss on the way down. Of course that only works if we allocate a small percentage to it and don’t do something dumb like say let’s go 50% long that spread. That’s what got people into trouble with the push spread trade. It was the same general concept. By a small position that has the same impact on the upside but has a smaller impact on the downside.

In terms of the math, it usually takes the market 60 days to fully develop a rally. Like if you look at every past rally, it only takes the first 60 to 80 days where most of the gains are produced. So we would want to look at 60 to 80 trading days into the future from a total of something like 25 days from the top. So we would want to count to 25 days from 637 to share down to a correction point and then we add all of that to the days to expiration. And then we may add a bump for conservatism.

That way, the QQQ could potentially have a correction in November, December, and even January and we’d have sufficient time to recover.

Again, this would only work if it requires us to put up a smaller amount of capital. If we can’t find a spread that produces that outcome then we probably don’t do it at all. Instead of what we might do is put on a very tiny long trade that produces big time under the assumption that the QQQ does in fact bottom at 8%.

So for example, we wouldn’t be taking a big position here we would be buying something like a small $10,000.00 position (3%) that pays off big time if the QQQ really only sustained an 8% correction.

Let’s be realistic if the QQQ only sustained an 8% correction and bottoms right at 8% and begins a new true rally that rally is gonna produce 20% returns in just a handful of months we can buy a relatively near term call spread that’s way out of the money for a very small amount of money that would produce a massive impact

So there’s three different ways to approach things basically we can either buy a very tiny call spread that represents a very small 3% position That tiny call-spread has built into it the assumption of a bottom at 8% meaning if we don’t bottom at 8%, the call spread probably expires worthless. It’s a true opportunity cost insurance. Because if you buy a $10,000 spread at $1.00, and the spread can potentially produce at 10 X then you’re talking about a 100 K return. We can probably buy even a smaller position and produce the impact.

The other way to approach things is to buy a spread that we are very confident is going to end up in the money. The production and return rate is going to be really low. And that’s because we are gonna be buying so far out into the future that we can almost guarantee the QQQ is gonna end up at our target point. There we might put up a 15% position. The hope is that 15% position produces the same return as would a 50% lead position. Finally, we can just do what the strategy dictates which is to just buy a 50% long position at 8%. We hold onto a larger hedge. The larger hedge does the work for us because if he continues to go lower, we will see a draw down in the 50% long position, but our put position will go up in value in lock step. Then as the put explode in value, we do what we did in April, which is to close the position and then go along.

We will discuss more in a post.